A week ago at the CFA Institute's 2010 Annual Dinner, Baupost's Seth Klarman stole the spotlight by announcing to everyone that he was "more worried about the world than ever" while making it clear that he was on the same Jim Grant and Julian Robertson "Treasury put" bandwagon. Yet another speaker present at the event, who undeservedly received much less attention, was CLSA'a Russell Napier, who has long been warning about precisely the thing that all asset managers are realizing rather belatedly, that Treasuries are a very "fundamental asset bubble." The only relevant questions, which Napier has previously discussed extensively, are "when do treasuries crash" and "what do you do" when that happens. The attached presentation provides some color on both.
Russell Napier, whose Anatomy of the Bear (available for a pdf-special $3.95 steal on DocStoc) is one of the better market analysis books available, had one quite insightful observation. As the CFA noted in its press release on the matter, "One point that Mr. Napier made toward the end of his presentation was that the difference between current borrowing and previous peaks in government debt is that previous surges in the debt load were linked with the financing of conflict. As he put it, the current borrowing is to keep people alive rather than to kill. The implication for the global economy of this key difference is that social programs to subsidize a certain quality of life are not a profit-making endeavor in the same way as traditional twentieth century conflicts." We wish we were as sanguine about this conclusion as Mr. Napier. With a rapidly deteriorating geopolitical situation in both the Middle and Far East, perhaps the massive entitlement spending has been nothing short of a diversion from the the traditionally massive "defense" spending. After all, there have been over $257 billion in defense vendor payments by the US Treasury since October, an outlay smaller only than Social Security Outlays and Medicare.
And since Napier's perspective has been largely ignored by the Mainstream media, we provide a link to his most recent comprehensive presentation on the topic of the Treasury bubble from earlier this year. In it, Napier takes (apriori) on a point made last week by Albert Edwards, an states that "balance of payments is key, not current account" pointing out that bigger CA deficits do not necessarily mean falling reserves as can be seen in the Thailand case, leading him to conclude that "Asian reserves will grow as capital flows reverse." Furthermore, back in February, Napier predicted perfectly the most recent TIC data which showed a record foreign capital flow into US securities (whether this was predicated by the capital flight ouf of Europe is largely irrelevant). Napier also questions the role of US commercial banks, and is confident they can plug a hole of up to $1 trillion in Treasury demand, saying "bank purchases of government debt can reflate America" in one of the most vicious Catch 22s, since the Fed funds banks at the discount window with money used to subsequently purchase safe assets, thereby monetizing debt with one small step of separation, a topic long discussed by Zero Hedge. Another key point is the recently notable observation on the plunging M3 via Ambrose Evans-Pritchard - as Napier shows this is certainly not the first time that broad money supply has contracted and led to lower inflation. The real question is what happens to credit demand in a disinflationary phase, all else equal, which however thanks to Europe, will not be the case for a long time.
Lastly, the Asian expert analyzes the role of governments, and specifically those of Asia and China as a preamble to the great Treasury bubble pop:
- China’s return to gradual appreciation of the renminbi does not stop funds pouring into Treasuries
- A one-off revaluation was not spurred by 8% inflation in China in 2008 so it will not happen now
- Capital controls are coming in Asia
- Capital controls will be insufficient and credit controls will follow
- Such measures shorten the duration of the great distortion but still current due to CA surpluses
While Napier does not provide the ever-elusive answer on when to expect the bubble pop, his insights give some more variables to juggle as we all await the bursting of the greatest bubble in capital markets history.